Business in Times of Corona: Wise Words from Omaha

The life lesson imparted by the Oracle of Omaha does not require much deciphering: Cash is King. Long criticised for hoarding large amounts of readily deployable cash, the third largest publicly listed company in the world, Berkshire Hathaway, stands to profit handsomely from the extreme volatility that has infected global markets. The company’s cash reserves hover around the $130 billion mark which now allows it to scoop up shares at steep discounts and broker highly lucrative preferred stock deals in a repeat performance of Berkshire’s earlier bold move into Goldman Sachs.

At the height of the 2008 banking crisis, and just before the US Congress approved its $700 billion bailout package, Berkshire Hathaway agreed to fork over $5 billion to Goldman Sachs, receiving in return preferred stock with a juicy 10 percent coupon attached, in addition to warrants to purchase another $5 billion-worth of common stock at a strike price of $115 per share. In the years that followed, those warrants were duly exercised. Then, in 2011, the bank also exercised its right to repurchase the preferred stock at a 10 percent premium. In the end, the original $5 billion deal netted Berkshire Hathaway a cool $1.8 billion whilst the company made another $2 billion in book value on the common stock component of the transaction.

The company chaired by Warren Buffett, who in 1964 acquired the then-failing textile mill in a rare fit of anger and transformed it into a corporate conglomerate, usually moves whenever nobody else dares. As such, Berkshire Hathaway is the corporate embodiment of Billy Ocean’s famous hit song When the Going Gets Tough, the Tough Get Going.

Mr Buffett is not just a keen judge of market sentiment but may also be remarkably prescient. In 1987, he discussed ‘super-contagious diseases’ in a letter to investors. He noted that there are ‘occasional outbreaks’ and that these will ‘forever occur’ with unpredictable timing. However, Mr Buffett was not referring to any particular medical condition, but to greed and fear – two ‘epidemics’ that periodically sweep the market. His recipe for dealing with such outbreaks was simple yet elegant as befits a sage: ‘Be fearful when others are greedy and greedy when others are fearful’.

Mr Buffett’s greed is quite different from the ‘greed-is-good’ mantra deployed to devastating effect by the fictional Gordon Gekko in the 1987 blockbuster movie Wall Street: Rooting out reliable long-term winners, sporting sound business models grounded in reality, from amongst the rubble of a shattered market is a Berkshire Hathaway specialty. The company seizes opportunity with an almost uncanny precision but will forego quick riches to focus on medium- to long-term profits – huge ones mostly.

Noting, rather sarcastically, that in a bull market the rewards offered to shareholders become ‘gloriously’ uncoupled from corporate performance, Mr Buffett offered another precious nugget of advice in true oracle-like fashion: “We have no idea – and never have had – whether the market is going to go up, down, or sideways in the near- or intermediate-term future.”

Late February, after he presented Berkshire Hathaway’s annual results, Mr Buffett was asked to shine his light on the then rapidly gathering corona storm. He recommended investors ignore the headlines and focus instead on the underlying metrics which usually do not materially change in the space of a day or two. Mr Buffett went on to explain that as a life-long buyer of stock, he quite likes discounts and thinks that investors should celebrate the moment: “Who doesn’t like to buy at low prices?”

In early March, the near-universally revered investor declared that the twin punches of the plunge in oil prices and the spread of the corona virus will ultimately prove less devastating to markets than the unexpected 1987 crash (Black Monday) and the 2008 financial crisis. Mr Buffett also said that he will wait until the first week of April to evaluate the situation and decide on any changes to the annual Berkshire Hathaway shareholder weekend – aka the Woodstock of Capitalists – set to start on 1 May. He later said that the event will take place ‘irrespective of conditions’ but may take another form.

Remarkably, amongst the companies now clamouring for help are a large number of corporates that have ignored the priceless cash-is-king advice and squandered their reserves on vast stock buyback programmes and generous dividend pay-outs to artificially inflate share prices and placate investors who – blinded by all that glitter – often failed to notice key performance indicators that showed below-average results.

Boeing and the major US airlines that are its main clients claim to need some $110 billion in federal aid to ride out the Corona Recession. Yet the troubled airplane manufacturer, whose flagship 737 Max is still grounded, ploughed some $43 billion back to investors over the past decade. Over that same period, the six major US carriers spent an estimated $47 billion on share buybacks with American Airlines leading the pack. Of the seven companies, six have watched their share prices tumble by 60 percent or more as air travel ground to a near-halt. Only Southwest Airlines managed to limit the damage to minus 37 percent.

In the knowledge that federal authorities will expend massive amounts of cash to ensure the survival of the airline industry, Goldman Sachs earlier this week upgraded Boeing’s stock to a solid ‘buy’ rating. In a rare moment of clarity, President Donald Trump sided with Democrats and warned the industry not to take government money and use it to buy back stock.

Impressed by the unexpected blowback from the White House, the Airlines for America (A4A) lobbying group pledged to limit executive pay, eliminate stock buybacks, scrap dividends, and keep their workforce intact for the life of the requested bailout loans. The industry group seeks $29 billion in grants and another $25 billion in loans and tax breaks.

Hours after the US congress greed on a $2 trillion relief package, its biggest-ever, global markets tentatively bounced back although much of the gain was realised on Tuesday in anticipation of the deal. Seesawing markets continue to demonstrate an exceptionally high degree of volatility with investors wondering if ‘huge’ is enough to break the downward spiral and claw back earlier losses.

Almost across the board, analysts and economists are forecasting an unprecedented decline in business activity with the attendant rise in unemployment numbers. Few share the apparently fact-free optimism displayed by President Trump who earlier in the week predicted that the country and its economy will be up and running, and open for business, by Easter – barely three weeks from now.

The stimulus package that is shortly to be enacted includes a $350 billion lifeline for small businesses and $500 billion in aid for large corporates. In addition, every adult earning less than $75,000 annually, will receive a one-time $1,200 pay-out (plus $500 per child). Economists welcome the measures but fear that it may not prove enough to many of the smaller businesses and household that face an ‘extinction-level’ event. Those were the words used by John Lettieri, head of the Washington-based Economic Innovation Group thinktank, to describe current events.

However, the last word and final judgment on the deal is to the markets. If the $2 trillion cash infusion should manage to put a floor under share prices, the recession’s inverted curve may yet be flattened just enough to inspire a semblance of investor confidence in the ability of governments to not just handle the crisis, but trace and clear a path out of it.